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Bond Report: 2- and 10-year Treasury yields jump to highest in 3 years after Fed’s Brainard points to rapid reduction of balance sheet

Treasury yields moved substantially higher across the board, with the 10-year rate breaking above 2.5%, after Federal Reserve Gov. Lael Brainard said she expects the central bank’s almost $9 trillion balance sheet to “shrink considerably more rapidly” than in the previous recovery.

What are yields doing?

The yield on the 10-year Treasury note

rose to 2.533%, compared with 2.409% at 3 p.m. Eastern on Monday

The 2-year Treasury note yield

was at 2.518%, up from 2.426% Monday afternoon.

The yield on the 30-year Treasury bond

was 2.582%, up from 2.473% late Monday.

Market drivers

In a speech on Tuesday, Brainard said that given a U.S. economic recovery “considerably stronger and faster” than in the past, she expects “the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017–19.”

Brainard, regarded as one of the most dovish members of the rate-setting Federal Open Market Committee, also said “inflation is much too high and is subject to upside risks,” and that “it is of paramount importance to get inflation down.”

Her remarks appeared to give renewed energy to Tuesday’s bond selloff, which sent yields up by 11 to 15 basis points across the curve during the morning. Meanwhile, the 10-year rate rose back above its 2-year counterpart — undoing the inversion of that part of the curve, which had been seen as a possible early signal of a recession down the road. A persistent inversion of that area of the curve is a phenomenon that has historically preceded recessions, albeit with a potentially long lag.

Read: Risks tilt toward a deeper yield curve inversion as some investors discount its recession-signaling power

Also see: Stocks are rallying because of what an inverted yield curve says about the Fed and inflation, strategist says

New York Fed President John Williams and San Francisco Fed President Mary Daly, who both spoke recently, are also set to deliver public remarks on Tuesday.

Data released Tuesday showed the U.S. foreign-trade deficit dipped to $89.2 billion in February, but stayed near a record high. The S&P Global services purchasing managers index for the U.S. came in at 58 for March versus an initial reading of 58.9. And the Institute for Supply Management’s March services index rose to 58.3% in March from 56.5%, matching forecasts.

Minutes of the Fed’s March policy meeting, due Wednesday, may be the main event on the data front this week. Investors will parse the summary for clues to the Fed’s plans for future monetary tightening, including the path for shrinking the central bank’s balance sheet.

Investors also continue to monitor developments in Ukraine, as Western leaders said they would investigate evidence of alleged war crimes by Russian forces and talked up the possibility of additional sanctions against Moscow.

What do analysts say?

“Headlines from Brainard have reinforced the call for a May balance sheet runoff announcement, noting that ‘the Fed will shrink the balance sheet at a rapid pace as soon as May,’ ” according to BMO Capital Markets strategist Ian Lyngen.

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